Views From the Floor - Kinks, Curves and JGBs

A potential way to beat the ‘widowmaker’ trade; and the implications of a higher carbon price in Europe.

La Niña’s impact on the jet stream could spell relief for natural gas prices and other soft commodities; and has the Bank of Japan’s yield control failed?
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Kinks in Japan’s Curves

“We do not expect yield curve control to persist much longer,” we wrote in November last year. The following month, the Bank of Japan raised the upper bound it would defend on 10-year Japanese Government Bonds (‘JGBs’) from 25 to 50 basis points. This evidently is not the end of curve control, but it may be the beginning of its end.

The effect of the decision wasn’t limited to the 10-year point on the curve; rather, the entire curve has moved higher, with the kink still apparent at the 10-year tenor where BOJ intervention is focused (Figure 1). The nomination of a new BOJ governor has added to the sense that a more definitive end to curve control is approaching, with the bank having had to buy record values of JGBs in December and January to protect its cap (Figure 2).

If all this pressure does ultimately break the policy, how can investors position themselves to gain from an increase in JGB yields? The obvious trade is to short JGBs, but the challenge here is that the BOJ now owns around 60% of the total JGB market and almost all ‘on the run’ (the most liquid, recently issued) 10-year bonds.1 Another option is to express the same trade through bond futures. Here, though, the problem is the cost of rolling a short position in the front contract of the 10-year futures into the next contract along the curve. This is similarly a function of the BOJ owning so much of the 10-year bonds that would be cheapest to deliver.

Eliminating these two avenues leaves us the possibility of using the swap market. This, in our view, has more merit as a strategy. Comparing Japan’s swap curve with its yield curve, we see that there is no anomaly at the 10-year maturity for the swap (Figure 3). Yet even this premium seems to us to understate the potential for Japanese yields to climb higher if curve control is more officially retired.

Figure 1. I18 JPY Japan Sovereign Curve Last Mid YTM

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Source: Bloomberg; as of 1 March 2023.

Figure 2. BOJ Bond Buying

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Source: Bloomberg and Bank of Japan; as of 1 March 2023.

Figure 3. JGB Yield Curve Versus Overnight Indexed Swap (OIS) Curve

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Source: Bloomberg; as of 1 March 2023.

Carbon’s Atmospheric Cost

On 21 February 2023, the price of carbon allowances traded under the EU’s Emissions Trading System (‘ETS’) breached €100 a tonne for the first time in the scheme’s existence; Figure 4 reflects this appreciation in the tradable futures market. This is significant for a market that has long been criticised for being too lax. Launched just before the Global Financial Crisis, the carbon price was held down for much of its history by a combination of lower levels of industrial production and a high number of available carbon credits.

Now, not only is economic activity recovering (with coal representing a greater share of Europe’s energy mix after Russia’s invasion of Ukraine disrupted oil and gas supplies), but the EU is also tightening its regulations. The ‘Fit for 55’ package aims to reduce greenhouse-gas emissions by 55% by 2030. In addition, in December 2022, European policymakers agreed to double the pace at which carbon allowances are being cut (from 2.2% per year to 4.4% by 2028), to expand the ETS framework to new sectors such as maritime transport, to create a new ETS for buildings, road transport and fuels, to phase out free allowances for certain sectors, and to introduce a carbon border tax to prevent the carbon leakage that occurs from companies offshoring and then importing back into Europe.

This all suggests that the carbon price can remain elevated, which matters both because investors can trade carbon futures and because of its real-world impact. Goldman Sachs has estimated that a global carbon price of €100 a tonne could be enough to reduce global emissions by around 50%2, and according to the International Energy Agency carbon capture becomes more economically viable for sectors including power generation, cement, and iron and steel at higher price points (Figure 5). This could form a virtuous cycle, as the higher cost of emissions incentivises companies to invest in their own decarbonisation and the money raised by the ETS goes into the EU’s Innovation Fund that focuses on low-carbon technologies.

Figure 4. ICE EUA Futures

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Source: Bloomberg; as of 1 March 2023.

Figure 5. Levelised Cost of CO2 Capture by Sector

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Source: IEA; as of 26 October 2022. This is a work derived by Man Group from IEA material and Man Group is solely liable and responsible for this derived work. The derived work is not endorsed by the IEA in any manner.


With contributions from: Oliver Whitehead (Man AHL – Head of Investment Risk) and Carl Hamill (Man AHL – Principal Quant)


1. Source: Bloomberg; as of 1 March 2023.
2. Source: Goldman Sachs Carbonomics; as of 1 March 2023.

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